Walgreens recently reported results that fell in line with our long-term outlook for the retail pharmacy, and we are reiterating our $70 fair value estimate and no-moat rating as the firm continues to try to close the Rite Aid acquisition. The firm has been successful recently in winning prime positions on the preferred pharmacy lists for UnitedHealth, Express Scripts, and other PBMs. Walgreens has been particularly aggressive in becoming the anchor pharmacy for many Medicare Part D plans. In order to obtain these prime positions, the firm has materially discounted its generic inventory. While this tactic has allowed it to grow its prescription drug market share, it has come at the cost of profitability with gross margins for the firm’s gross margins compressing 39 basis points for the quarter. Management hopes to drive volume increases for other non-pharmaceutical products in order to fill the profit gap. However, this dynamic has yet to develop with same-store sales for its front-of-the-store products (non-pharma products) falling 0.8%. Management did note that same-store sales for its health and beauty operations did increase, but we are skeptical that these increased sales can drive long-term growth. From our perspective, the firm has been discounting both its pharmacy and non-pharmacy products in order to drive foot-traffic and basket size. This strategy has yet to consistently drive same-store sales increases, and operating margins have yet to expand. We believe it is critical for the firm to scale its asset and cost basis in order to preserve an acceptable level of shareholder return.

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